RBI recently released the operating guidelines for the Small Finance banks and Payments Banks on October 6, 2016. To take stock of these, we have put together a brief comparison of the regulatory requirements of these banks against those for universal banks.

Payments Banks (PB)

Small Finance Banks (SFB)

Universal Banks (scheduled commercial bank /
SCB)

Functions

Payments and Remittances

Yes

Yes

Yes

Credit

No

Yes,

a)75% of ANBC to qualify under PSL. While 40% of its ANBC should be allocated to different sub-sectors under PSL as per the extant PSL prescriptions, SFBs can allocate the balance 35% to any one or more sub-sectors under PSL where it has competitive advantage, and,

b) Atleast 50% of loan portfolio should have loans and advances not exceeding Rs. 25 Lakhs

SFBs can participate in securitisation as originators for risk transfer but not as purchasers of other banks’ loans

Yes

40% of ANBC to qualify under PSL

Savings

Yes, only demand deposits (savings and current accounts), aggregate limit per customer shall not exceed ₹100,000. Amounts beyond this limit can be swept into accounts opened for customer at a SFB/SCB, with prior written consent of customer.

Yes – both demand and term deposits

Yes – both demand and term deposits

Business Correspondent (BC)

Yes. Can become BC to another bank, and in the process offer credit. Also can engage BCs, including those of promoter/ partner/ group companies at an arm’s length basis, for expanding their business.

Cannot be a BC to another bank. Yet can engage BCs, including those of promoter/ partner/ group companies at an arm’s length, for expanding their business. Interoperability of BCs is allowed, though it is unclear what interoperability means in this context, except for opening of deposit accounts. Offline BCs will not be allowed. No requirements to have base branch for a set number of BCs/ access points.

Can use BCs to expand their business with no restrictions on having a set number of BC’s to be mapped to a base branch. While a BC can be a BC for more than one bank, at the point of customer interface, shall represent and provide banking services of only one bank. Offline BCs are allowed provided that all off-line transactions are accounted for and reflected in the books of the bank by the end of the day.

Prudential Requirements

Capital Adequacy Requirements

15% – their risk exposure would be almost entirely limited to operational risk*

Only in Govt Securities (atleast 75% of Demand Deposit Balances) and in demand and time deposits in SCBs

As applicable to commercial banks

As per extant guidelines

Other Activities

Products

Some form of prior RBI approval required for
products to be sold by PB. RBI also reserves the right to restrict or discontinue the products being sold by the PB

NA

NA

Derivatives

Only for the purposes of hedging foreign currency positions arising from business activities.

Only the below mentioned derivatives can be used. Also no credit derivatives cannot be purchased or sold:
a) interest rate futures for proprietary hedging;
b) Foreign exchange derivatives to hedge foreign currency positions arising from business activities

No such restrictions

Para Banking Activities

Can undertake other non-risk sharing simple financial services activities, not requiring any commitment of their own funds, such as distribution of mutual,fund units, insurance products, pension products, etc. with the prior approval of the RBI and after complying with the requirements of the sectoral regulator for such products

Please let us know your thoughts/feedback on the above comparisons in the comments section below.
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* The prudential frameworks for market risk and operational risk are being examined by RBI and the instructions in this regard are expected to be issued separately.

Only about half of Indian adults have access to an account of any kind. The number is even lower for the poorest 40 percent (World Bank, Global Findex 2014). Furthermore, there are only 13 commercial bank branches per 100,000 adults (IMF, Financial Access Survey 2014). Keeping in mind the low levels of financial inclusion in the country, the Indian authorities have developed a broad strategy to improve access to financial services, as outlined in the report by the Committee on Comprehensive Financial Services for Small Business and Low Income Households, led by Nachiket Mor. Among the committee’s recommendations, payments banks are one innovative tool to further India’s goal of greater financial inclusion.

Payments banks are different from regular banks. They can only accept deposits up to Rs. 1 lakh per person, roughly $1500, and cannot grant loans. Furthermore, payments banks can only invest their money in safe government securities and other highly liquid assets. Their primary objective is to further financial inclusion by providing access to small savings, payments and remittance services to low-income customers without compromising financial stability. By leveraging technology and tapping into their large networks, these banks might potentially allow millions more people, many in remote corners of India, to operate bank accounts, with often very small sums of money. In August 2015, the Reserve Bank of India (RBI) granted “in-principle” licenses to eleven entities to launch payments banks.

While it is too early to assess results, as these banks are not operational yet, a valid question is whether the regulations governing these payments banks are consistent with fundamental regulatory principles for improving financial inclusion while protecting financial stability and integrity. To answer this question, I compare key characteristics of the payments banks against major recommendations in the recently released report, Financial Regulations for Improving Financial Inclusion, by the Center for Global Development (CGD), a Washington-based think tank. Prepared by a high-level Task Force, the report advances three major recommendations (among others) for expanding financial inclusion in a safe and sound manner:

Encourage competition by allowing new and qualified providers to enter the market

Create a level playing field between different providers by making the regulatory burden proportional to the risk posed by providers to individual customers and the overall stability of the financial system

Payments banks certainly encourage the entry of new, qualified and innovative players. The entities licensed to become payments banks encompass a broad range of sectors, including telecommunications, finance and banking, IT, and postal services. The first payments bank is expected to be operational by the end of this financial year.

The licensing of payments banks is contingent upon various players meeting the appropriate entry criteria. The approved entities need to have a solid track record and ability to conform to the highest standards of service. More details about the licensing process can be found here. A thorough regulatory and licensing regime is crucial for financial stability. After all, India’s experience with expanding rural banks in 1976 without a proper regulatory framework ended in huge losses in 1991. India’s clear licensing requirements for payments banks are consistent with the CGD report’s recommendation to encourage entry of a wide variety of qualified providers of financial services. Of course, given the restrictions on payment banks’ activities, the implications of “fit and proper” are quite different for these banks compared to traditional banks.

Leveling the Playing Field Between Providers of Financial Services

Since payments banks do not undertake credit risk, the RBI has stipulated a minimum capital requirement of Rs. 100 crore ($15 Mn) for payments banks (among other requirements), unlike traditional banks that must meet a capital requirement of Rs. 500 crore ($75 Mn). As these payments banks assume lower risk, it only makes sense that they have to carry a lower regulatory burden.

However, if the entities licensed to become payments banks wish to expand their activities beyond those allowed for payments banks, they would need to be licensed to become full-service banks. Similarly, if the payments bank reaches a net worth of Rs. 500 crore and becomes critical to the stability of the financial system, diversified ownership will be mandatory within three years. Such a risk-based approach is essential to ensure a balance between fostering innovative financial services and ensuring the safety and soundness of the financial system, as recommended in the CGD report.

Applying Know-Your-Customer (KYC) Rules

India has already encouraged improvement in financial access as well as up-take of national ID (Aadhaar) by allowing people to open restricted bank accounts subject to later showing proof of identity. These restricted bank accounts have limits on balances and activities. Similarly, simplified KYC requirements would be applied to “small accounts” transactions through payments banks. Payments banks are expected to encourage the expansion of these types of “small accounts” through their extensive networks. Furthermore, Aadhaar will play a key role in facilitating the take-up of “small accounts” with simplified risk-based KYC processes, as recommended in the CGD report.

While there is no one-size-fits-all solution to improve financial inclusion, there are important lessons to be learned from India’s step to approve payments banks. After India’s previous experiments with different efforts to improve financial inclusion, payments banks offer one promising way towards better financial access. India’s forward-looking vision to leverage digital finance combined with innovation-friendly regulations could pave way for a bright and safe future for payments banks.

Yesterday, the RBI announced in-principle Payment Bank licenses for eleven applicants. To put things in perspective, there were two new bank licenses in the last decade. The successful applicants include the largest telcos, corporate houses, Business Correspondents, a Depository and a mobile wallet provider. The number of licenses and the diversity of the pool bode well for the scale and scope of what will be pursued by this new category of banks in the years to come.

While previous licensing rounds were always for “full-service” banks, this represents the first round of licensing for a differentiated banking design following on RBI’s Discussion Paper on Differentiated Banking and the recommendations of the Committee on Comprehensive Financial Services for Small Business and Low-Income Households. To recap, a Payment Bank can provide deposit and payment products but cannot lend. This very important design feature has an important implication from a regulatory perspective – Payment Bank promoters now cannot “cross the floor” in terms of raising public deposits and lending these out. Therefore, the implications of “fit and proper” are now quite different for this group of promoters. This perhaps explains why this round produced eleven licenses against two in the last decade. And at this stage of development of the Indian banking sector, these eleven new entrants could be just what the doctor ordered for innovations on savings and payment services while not adversely impacting the stability of the banking system. An IFMR Finance Foundation working paper reported that the asset portfolio of the average rural household in India is composed almost entirely of two physical assets—housing and jewellery with little to no financial assets of any type.

Also from a financial system design perspective, this is a timely acknowledgement that the credit and payments strategy must evolve differentially within the broader financial inclusion strategy. While progress on credit would necessarily have to be much more measured and prudent no matter what strategies are adopted given the inherent risks and customer protection concerns, there is an urgent need to make access to payments ubiquitous. Yesterday’s announcement is an important step forward in that direction.

The RBI has published final Guidelines for Licensing of Payments Banks in India after reviewing feedback and comments obtained by it on the draft guidelines that were published in July 2014 and covered in an earlier post.

The Guidelines have permitted Payments Banks to be established under the Banking Regulation Act by a wide variety of eligible institutions and to be engaged in providing demand deposits and payments and remittance services to domestic underserved populations of small businesses and low-income households through own branches, ATMs, and BCs. There will be no credit intermediation including in the form of credit cards through these banks. An initial restriction of upto Rs.100,000 a year as maximum balance has been placed on such deposit accounts per individual customer. Payments Banks can be part of any card payment network and are permitted cash-out at branches, BCs, ATMs and Point-of-Sale terminals.

The final Guidelines provide more leeway to Payments Banks than what was previously proposed in the draft guidelines with respect to the following aspects:

Deployment of demand deposit balances

While previously 100% of funds were to be deployed in Government securities and T-bills with maturity upto 1 year, the final guidelines relax this to requiring a minimum of 75% in such investments. The Payments Banks are free to deploy the remaining 25% in current and time/ fixed deposits with other scheduled commercial banks for operational and liquidity management purposes. This component will also contribute to risk-weighted assets for market risk as previously there would have been be no capital required to be placed for market risk (due to zero risk-weights for Government securities/T-bills). Also, temporary liquidity needs can be met through the interbank uncollateralised call money market and the collateralised repo and CBLO markets.

Non-risk based backstop

The leverage ratio while previously set at not less than 5% (ie., outside liabilities must not exceed 20 times of its networth / paid-up capital and reserves), has now been eased to at not less than 3% (outside liabilities not exceeding 33.33 times of its networth/ paid-up capital and reserves). This shift is justified as a leverage ratio of 5% was more conservative than what is prescribed even for full-service banks, and also because Payments Banks have no credit risk to warrant such a strict requirement.

Retaining ownership by promoters

The draft guidelines had required mandatory dilution of promoter holding to prevent any self-dealing by the owners. The final guidelines specifically clarify that it does not mandate a diversified ownership structure, which would have been required if these banks were undertaking credit activities. Payments Banks can therefore be set up as fully-owned subsidiaries so that promoters can leverage adjacencies arising from the use of existing infrastructure of the parent companies by the subsidiary Payments Bank. When the Payments Bank reaches the net worth of Rs.500 crore, and therefore becomes systemically important, then diversified ownership and listing will be mandatory within three years of reaching that net worth. Payments Banks are free to list themselves before this too.

It will be exciting to see how the creation and performance of such Payments Banks will evolve now that the final guidelines have been published by the regulator.

The Committee on Comprehensive Financial Services for Small Businesses and Low Income Households recommended developing a vertically differentiated banking structure, in which banks specialise in one or more of three functions- payments, credit delivery and retail deposit taking. The Committee, thus, recommended the licensing of new categories of specialised banks including Payments Banks and Wholesale Banks. Accepting the Committee’s recommendations, the Reserve Bank has released Draft Guidelines for ‘Licensing of Payments Banks’. The Draft Guidelines state that the “primary objective of setting up of Payments Banks will be to further financial inclusion by providing (i) small savings accounts and (ii) payments / remittance services to migrant labour workforce, low income households, small businesses, other unorganised sector entities and other users, by enabling high volume-low value transactions in deposits and payments / remittance services in a secured technology driven environment.

Such Payments Banks would engage in collecting demand deposits (ie, savings bank deposits and current deposits) and provide payments and remittance services, such that the deposits are deployed in Government securities and T-bills (with maturity upto one year) permitted by RBI as eligible for meeting SLR requirements. With access to the Payment and Settlement System, Payments Banks will be permitted to carry out cash-in and cash-out through channels such as own branches and through BCs, and can additionally do cash-out at ATMs as well as POS terminals (subject to instructions under the Payment and Settlement Systems Act). RBI would also be open to entities interested in offering transactions through the internet (similar to the Virtual Bank model in Hong Kong). The deposits will be protected by deposit insurance under DICGC.

Transaction limits while currently set at Rs. 100,000 as maximum balance per customer, can be subject to revision based on performance of this category of banks. Also, if ‘small accounts’ are being offered, these would enjoy the benefit of simplified KYC norms.

Payments Banks are expected to stay away from credit intermediation on own books and thereby not be exposed to credit risk (nor market risk if investments are held to maturity obviating the need to mark-to-market) but be exposed to significant operations risk as well as liquidity risk. The minimum capital requirement set at Rs. 100 cr (one-fifth of that for a full-service bank) is substantiated given that the expectation is that the operations will entail significant investments in technology and fixed assets. Although there will be no credit risk, the Draft Guidelines have envisaged a minimum capital adequacy ratio of 15%, as is the case with NBFCs, the calculation of which will be based on simplified Basel I requirements (perhaps, risk weights for cash in hand and cash in bank would take prominence in the absence of loans and other assets).

Payments Banks will necessarily have to be public limited companies and entities interested in setting up Payments Banks are to have a past successful track record of atleast 5 years in running their business, be it an NBFC, a corporate BC, mobile telephone companies, super-markets or others. Interested banks can also set up Payments Banks subsidiaries subject to shareholding limits.

As has been in the case with the previous round of bank licensing requirements, Promoters of Payments Banks would need to systematically bring down their holdings from atleast 40% (locked in for the period of first 5 years), brought down to 40% within first 3 years, to 30% within 10 years, and to 26% within 12 years of commencement of business.